Brazil: The Different Ways of Privatizing

Contrary to the past rhetoric, the federal government has just finished the privatization (through concession) of several federal highways. The choice was to grant privilege to the end user of the service, instead of the standard model that was being adopted. It is important to understand the pros and cons of this new model especially in comparison to the previous one.

The for profit private sector is known to be a better manager than the public sector. It comes as a pleasant surprise that the current government, who had been a critic of the privatization, has just privatized, through concessions, important segments of federal highways. However, nothing was charged for the concessions. In exchange, the winning companies were the ones who offered to charge the lowest tolls (as a measure of the lowest operational costs for highway maintenance). In the alternative model adopted until now, the main goal was not only maintenance but also the commitment of future investments in the highways as well as returning to the government part of the capital allocated in the privatized asset. In turn, the auction notice specified the required investment for future improvements and set the toll price compatible with the minimum concession price demanded. The winning bid was the one that offered the highest price to the government.

A road usually brings countless benefits and, in general, these benefits are not completely captured by the final users. In case the social returns of a road are greater than its construction costs and the revenues from the tolls, budgetary resources should be used to offset the difference between the collectable tolls and the construction cost. This is even more truthful the more the highway is built in the middle of nowhere. Therefore, road segments that are financed exclusively with toll revenues should be built in developed areas, like the Rodoanel. It may not be recommended for the government to try to recoup, through concessions, the whole investment amount allocated in the highway. In the previous model (privatization for the highest price/bid) the main risk is that the toll price may be greater than its social costs, leading to social losses.

On the other hand, the current free concession model grants a subsidy to the highway user. The subsidy is being paid by the population as a whole. Though many agents benefited from the highway presence, their direct/final users are the ones who get the most from it. Therefore, it seems reasonable for final users to pay for the highway maintenance costs. They also should pay part of the initial investment (to build the road) as well as future improvements. The argument that the cost of capital is irrelevant once the road is built and hence the optimal toll is set by the variable costs is only valid in a world without growth and new investments. The analogy with a dam to generate electrical power is relevant. The cost of capital is high but the operational one is irrelevant. In the case of positive growth rates, the value to guide the price policy is equal to the operational cost plus the cost of capital. This is the amount that should be set to determine the energy tariffs. If one charges less than such amount, as it was the case in the Brazil during the 1980s, the users are granted a subsidy. This in turn, makes the system economically and financially not viable

In other words, the former model assures more resources for the government, in general, and for the expansion of the highway system, in particular. The main problem of such framework is that the whole society (and not only the users) has to bear the costs of any further investment in the highways. Clearly, the choice between the two systems is also politically driven. Given that privatization is a better choice than government control, the new model has some advantages. This is so because the highway user (the group who reaps the benefits) tends to be more vocal than the population as a whole, whose interests are diffused. One aspect that deserves to be praised is the low price of the toll, mainly due to a great number of bidders in the auction. Besides, because the current model has not been adopted in all federal highways the difference between the two models (in terms of toll prices) may reach 1000% and can deliver good political dividends.

The former privatization model was heavily criticized by the opposition, now in power, arguing that the government had misused the public assets. In other words, the assets would have been sold at a price that was lower than its real value at that time. Such contention is hard to sustain due to the sale procedures adopted in the auction. In the Vale do Rio Doce (CVRD) case, whose privatization is being challenged by a few judges, politicians and class unions, the dollar price of the company shares only increased in 1999. Indeed, it was only in 2001 that the CVRD shares started to decouple from the Ibovespa. Such fact is a strong indicator that the price paid to the government in 1997 was not low at that time and that managerial efficiency together with the price increase in iron ore since 2004 are the key factors for explaining the recent company’s valorization. Still, it is relevant to note that in the highway concessions, the model that maximizes the revenue for the government is the former one, and the current one not adding any revenues for the Treasury. There are different ways to privatize public companies and it is important to be aware of their implications.

It is positive that privatization has been resumed because it shows that the government has placed pragmatism above ideology. Good sign. We hope that the same principle is extended to the long list of structural reforms that is still being set aside.

Originally published by Valor Economico and translated to English by RGE monitor.